This extended example illustrates what happens to the EAC when we consider taxes. You are evaluating two
Question:
This extended example illustrates what happens to the EAC when we consider taxes. You are evaluating two different pollution control options. A filtration system will cost $11 million to install and $60,000 annually, before taxes, to operate. It will have to be completely replaced every five years. A precipitation system will cost $1.8 million to install but only $12,000 per year to operate. The precipitation equipment has an effective operating life of eight years. Straight-line depreciation is used throughout, and neither system has any salvage value. Which option should we select if we use a 12 percent discount rate? The tax rate is 21 percent.
Filtration System | Precipitation System |
Aftertax operating cost | |
Depreciation tax shield | |
Operating cash flow | |
Economic life | |
Annuity factor (12% ) | |
Present value of operating cash flow | |
Capital spending | |
Total PV of costs |